A new paradigm for portfolios

04 nov 2016 / por BlackRock

Structural economic changes are driving lower economic growth and a dramatic drop in bond yields. Investors should not expect bond yields to return to long-term levels. This means asset valuations need to be seen through a different lens.

The structural slowdown in global economic growth and dramatic drop in bond yields represent a paradigm shift that is forcing a rethink of portfolio allocations. Ageing societies and weak productivity growth have led to a persistent decline in economic growth. What is now considered a neutral policy rate for a central bank – one that neither stimulates nor restrains growth – has experienced a likely medium-term decline in the United States and other major economies.

This low neutral rate and large central bank ownership of government bonds are why we see long-term bond yields staying low on a five- to 10-year horizon. Investors should not expect bond yields to revert to historical averages, notwithstanding likely short-term swings. Low risk-free rates – the fundamental basis for gauging asset valuations – represent an underappreciated sea change in assessing future returns, in our view. Asset valuations need to be seen through a different lens.

Key takeaways

Investors need to reassess how to achieve return and diversification goals: perceived “safe” assets are looking less safe due to a variety of near-term risks (valuations, political and central bank uncertainty), while equities can generate more income in a diversified portfolio.

Structural forces imply the U.S. neutral real short-term rate (known as natural rate or r*) is now just 0.5%, suggesting nominal short-term rates should be anchored around 3.0%. That limits how high central banks will likely lift rates and thus how high long-dated bond yields are likely to go, in our view.

Low discount rates suggest that asset valuations should not fall back to historical means and thus relative valuations matter more, we believe. So take risk where you are most rewarded.

We see U.S. 10-year yields gently rising to average about 2.4% on a five-year horizon. We also see risks of occasional government bond sell-offs that may result in reduced portfolio diversification benefits.